On the Economic Stimulus Package

Reaction to Obama's economic stimulus package seems to be falling into two camps: Those who now believe that what is needed is a healthy dose of Keynesian economics (i.e. government spending) and those who continue to adhere to "supply-side" economics. The basic difference between the two is who decides how to spend the economic resources of society: the government or wealthy individuals acting collectively through free markets.

Supply siders will criticize the last sentence's qualification of "wealthy" individuals and talk about the average person, the small businessperson, etc., etc. In general, that's playing with words. Middle class 401K accounts were largely smashed by the bursting of the dot.com bubble, turning the "average person" to real estate equity, which in turn has been smashed by the real estate bubble. If you are one of the lucky ones and still making $250,000 and up, "tax cuts" may have some relevance, but as unemployment grows and foreclosures increase, tax cuts will be chump change to the magnitude of economic problems most of us will be facing.

Far, far more important than tax cuts will be "jobs" - both in re-employment and saving existing jobs, particularly those jobs that we all rely upon for the safety and stability of society (police, firemen, health care workers, etc.). I have nothing against free market solutions or tax cuts...if they work. And, I have a lot of doubt regarding their effectiveness as a stimulus at this point.

Basically, as noted a jillion or so times in these blogs, supply side economics argues that minimizing government expenditures and maximizing the wealth in the hands of individuals allows the individual to "reinvest" in the economy, whether it's through an investment portfolio or by purchasing a flat screen TV. That, in turn, ups demand and creates jobs.

In theory, and historically on several occasions in the past, this does work. Problem today is that it isn't the past. Things have changed. The investment portfolio has tended to have been dominated by over-valued assets and largely unregulated new "financial instruments." What was a great investment two years ago may not be worth much more than a lottery ticket today. All the additional tax cuts thinkable won't change the situation until we overhaul the financial system, re-establish some fundamental regulation and oversight and, the kicker, create new investment opportunities in new industries employing people in real jobs, making real products, for which there is a demand. As a twenty-something writer for Fortune Magazine noted yesterday on a CNN program devoted to the crisis, "the United States had a strong economy when we made things and sold them and will not be strong again until we make things and sell them."

Regarding the lower category of demand, those flat screen TV's, well most of them were bought on credit weren't they?

So, let's face it. Without the ability of the U.S. government to step in and borrow enormous sums of money (thus simply transferring every one's "credit problem" to the next generation via government deficits), the U.S. financial system and virtually the entire economy would have gone into bankruptcy last Fall. Get it? It is not very far from the truth to say that without tossing much of this supply side economics and free markets stuff out the window, capitalism would have pretty much completely failed at some point in the October - December 2008 period.

Ideologues die hard. So, when someone suggests that the answer to the current crisis lies through more tax cuts, let me suggest some of the illusions and delusions they are possessed by to justify the statement.

Supply side economics works, but only under certain conditions. In our case, it assumes several things, which in today's economy simply are no longer true. Basically it says that tax cuts = more disposable income = more investment = more demand = more jobs = labor scarcity = rising wages = a better world for everyone. It's the ultimate "win-win" situation...within the context of the economic system in which it is practiced. Problem is that for the last 20 years or so, that system has been global, not national. Income HAS trickled down; it has trickled down to the customer service worker in India (the person you talk to when you call to ask about your phone bill); to the factory worker in China (who builds the components of your flat screen TV, which is assembled in Indonesia and sold through a Japanese company to an American distributor, such as Wal Mart, or Target); etc.

Basic point: We may cut taxes all we want, but it until the investment flows and purchasing demands resulting from those cuts generate well paying U.S. jobs, they will not help members of the American Middle Class.

Within a global economy, the benefits of U.S. tax cuts will flow primarily to a) Americans lucky enough to be "investors" and b) workers outside our own borders.

Economic statistics support this. At the time the real estate bubble burst, wealth distribution was skewed toward the upper 5-10% more than at any time in our history since 1929 (nothing wrong with being rich, but if wealth becomes so concentrated that no one but the few at the top can purchase things, their numbers do not in themselves create sufficient demand for product; that demand, is generated not by actual widespread income or wealth increases, but by loose credit). Credit was at an all time high and American savings at an all time low (actually a negative figure).

A recent study by Moody Investors concluded that in terms of direct stimulus, food stamps comes in first, with each dollar spent generating approximately $1.73 in return. Corporate tax cuts came in last, actually costing the overall economy some $0.25 in each dollar cut.

In short, unless specific tax cuts can be restricted or conditioned by other tax incentives to hold savings within the U.S. economy and create U.S. jobs forget them; direct U.S. government spending is more efficient in that it may at least be more directed and controlled.

This is not to argue that many of the Democratic proposed government stimulus items are not equally stupid.

In the next post, I'll get into those.

P.S. Another word on wealth distribution. I have a theory that basically says there is a certain "optimum rate of capital absorption" for any given economic identity at any given moment. This holds true for individuals (e.g. the typical lottery winner) as well as for institutions (banks) or national or even the global economy. And, that there is a relationship (or correlation) between the amount of money in the system and overall investment risk. As available capital exceeds the optimum level, risk increases correspondingly. Liquidity that exceeds rational investment will still be invested...irrationally. Like eating too much chocolate. This, in some ways, relates back to income or wealth distribution - i.e. there may be some economically "optimum distribution," which allows for a wealthy investor class to "grow" the economy, and some sort of basic subsistence level for the poor, but distributes the majority of income across the majority of the population. Not suggesting that government do this; actually it already does, through fiscal and monetary policy, taxation, tariffs, etc.

Obama's Stimulus Package, Paul Krugman and the CBO

Today's NYT carries a column by recent economic Nobel Prize winner, Paul Krugman (Krugman writes a regular column for the NYT, as well as teaching at Princeton). Krugman's column criticizes the Obama economic plan as basically being too small to close the growing gap, brought on by the recession, between potential supply and real demand. Krugman's observation is largely based on yesterday's report and testimony by the CBO, or Congressional Budget Office.

Having watched the CBO hearing, I understand Krugman's concern, on its face. About the only positive aspect of the testimony was the name of the witness, the Acting CBO Director, Mr. Sunshine (I kid you not).

A smiling Mr. Sunshine, exhibiting rare wry humor and the appropriate power point presentation delivered little more than doom and gloom in substance. It was an apt follow-on to the Three Stooges press conference of yesterday and illustrates a facet of modern America that I've been complaining about for years...process over substance, or in these instances, presentation over message. It's sort of like the world's foremost scientists gathering before a Congressional Committee and testifying that the world will end in a week and the committee members walking away afterwards saying to one another: "damn fine presentation."

Hello...the sky is falling.

Aside from that however is my own observation that may offset Mr. Sunshine and Professor Krugman's concerns, i.e. the validity of the supply side potential and its significance to the overall U.S. economy relative to overall consumer demand. What this boils down to is the suggestion that an economy based on overextended credit and foreign imports isn't exactly a great goal to set for the post recession world. Rather than getting back to achieving our "full potential," as defined by the old rules (i.e. creating consumer demand) it may be more important to spend some time discussing exactly what that potential really is and to offer an explanation for the "demand side" in terms other than Wal Mart's quarterly sales figures.

In other words, two major points: 1) When we get through this and strip the economy of its over leveraging, largely phony financial instruments based on overvalued assets, and begin paying more attention to fundamental trade balances, manufacturing jobs and neglected infrastructure we may find we have a sounder, but smaller economy. 2) Given 1), the actual size of the stimulus package necessary to return us to the Land of Oz is largely irrelevant and that instead of searching for a way to the Emerald City, we should be looking for a way to get back to Kansas. Temporarily, this may not be good for the U.S. economy within the context of our position within the overall global economy, but may be better for the average American and consequently, in the long run, good for our economy.

In sum, the future of the American economy can't really be compared to its status/position over the last several decades while we were incrementally moving toward an unsustainable situation. The Obama stimulus package and the Bush Administration moves since the "emminient collapse" and initial bailouts are indications of a slow, but growing awareness that we cannot simply go back to a situation that repeats the errors of the past, which have been similar to building a foundation with half the bricks that are prudent and necessary to sustain the structure.

Supply and demand require measurements that go beyond retail sales and consumer consumption. Given Krugman's basic Keynesian philosophy, his concern regarding these outmoded measures is curious.

And So It Goes...

Obama gave a major speech today on his economic stimulus package. While details are still sparse, Congressional Democrats didn't let that stop their criticism. [Note: I was afraid of this...the most notable names among Congressional Democrats have been in the minority for so long, they are having problems understanding that they won the Presidency and control of both houses. It may take a special type of politician to survive in the minority and that that type is unsuited to represent the majority.

Anyhow, while Obama's speech indicated that he is well aware of the seriousness of the current economic crisis and its relationship to the "climate in Washington," Party congressional leaders virtually simultaneously offered additional proof that they do not. Messers. Durban, Schumer, and Dodd gathered to announce a major "breakthrough" in their "negotiations" with Citigroup to change the current bankruptcy laws (changes they all voted FOR a few years ago) allowing bankruptcy judges to restructure mortgage debt on primary residences (including forgiveness of a certain amount of principal). Curiously, the judges have held this power for second homes, vacation homes, yachts, private jets etc., but it was not granted for primary residences. [Note: I suppose the New Economy logic is that a primary home would be located near one's workplace and if you were in bankruptcy, your retirement home (or yacht) would be of more value to you.]

The three Stooges announced that after hard and difficult fighting with the financial industry, they had arrived at an important compromise. Citigroup has "agreed" to include primary home mortgages as subject to restructuring, including principal reduction, IF such mortgages are limited only to those in effect prior to the new law. In other words, they have agreed to support the change solely on a retroactive basis and not for future mortgages.

Ah...this is all becoming soooooo confusing. I use to think the American legal system - ex post facto law as in Article I, Section 10 of the Constitution - prohibited the passage of law retroactively. If so, the Three Stooges' announcement is simply window dressing. By modifying the Three Stooges' bill to apply solely to mortgages made prior to the bill becoming law and negating the modification for mortgages after the bill becomes law, Citigroup has its cake and eats it as well.

Further, why are the Three Stooges "negotiating" with Citigroup at all? The U.S. Government (and consequently, the U.S. taxpayer) is, following the Citigroup bailout of $20B+, the single largest Citigroup shareholder. [Note: Second largest is Dubai with $7.5B.]

Why is it that Congressional leaders continue to play the Emperor's New Clothes game?

Negotiating with Citigroup about the bankruptcy laws is like asking Nazis what they REALLY think about Jews.

It's like finding "good Germans" in 1945 or truly non-sectarian Iraqis in 2009. What the guy in Des Monies, Iowa or Peoria, Illinois understands is that the malfeasance and corruption of the American financial industry ran so broadly and deeply for so long, there are no good guys left.

And, what the Three Stooges need to understand is that this is a situation that is rapidly becoming one of you are either part of the problem or part of the solution and "negotiating" with idiots and/or criminals puts you in the camp of the former.

First Take on Obama's Largest Obstacle...the Democrats

Although the Obama transition has run into a few glitches - such as the Richardson appointment - it has thus far gone smoothly. However, the recent fiasco regarding Obama's replacement for his Senate seat perhaps points to what, I believe, will be the greatest obstacle to his message of "change," namely established "pols" within his own party.

Skipping for the moment the coming headaches concerning Schumer, Dodd, et al over how to effectively regulate Wall Street and the Rockefeller, Feinstein lukewarm response to Leon Panetta's probable appointment as head of the CIA, the event that illustrates this most clearly is Harry Reid's stance on the Blagojevich appointment of Burris to Obama's Senate seat. Reid's approach to representation is one of "party power politics" versus the rule of law and Democrats would be wise to remove him as their majority leader, seat Burris and leave Blagojevich to his fate within the Judicial system and probable impeachment by the Illinois State Legislature.

Reid's action to block Burris from the Illinois Senate seat portends the setting of an extraordinary precedent - i.e. the assumption that the Senate decides its own composition.

In doing so, Reid has singlehandedly elevated an albeit messy scandal to a matter of Constitutional principle.

Generally, States fill Congressional seats that become vacant between elections either through special elections or Governor appointment. In Illinois, under current law, it is the latter. Despite Blagojevich's impending indictment and probable impeachment, no one has argued that potential future removal from office eliminates his current powers. Indeed, one might make an argument that since removal from office may be accomplished only by either election or impeachment, he might well continue his Governorship from a jail cell. Thus, the combination of the Illinois Legislature's failure to act promptly in either impeachment or changing the appointment process prior to Burris' appointment and Reid's action have effectively overturned Illinois law and the democratic process.

Obama is probably recalling the old clique, "with friends like this, I don't need enemies."